New York City recently received top honors in Marcus & Millichap’s annual apartment market report. Healthy employment growth expectations and tight vacancies moved New York City to the number-one spot in the firm’s National Apartment Index (NAI).

“We’ve seen a tremendous appetite for properties in the last three to six months; it has returned almost to pre-recession levels for buyers interested in quality assets” in New York, notes J.D. Parker, vice president-regional manager and northeast regional director for Special Assets Services, Marcus & Millichap Real Estate Investment Services.

Marcus & Millichap expects 84,000 jobs to be added to the city this year, a nearly 2.5 percent increase in job growth year-over-year, notes Parker.

“As emerging economies get wealthier,” Parker adds, “one of the first places a lot of people want to visit is New York City. The city will benefit from the first of the world doing better, and that trickles down to real estate.”

But, as those living in and around the Tri-State area know, it’s not just the city itself that is affected by New York City employment statistics.

New Jersey—particularly the northern region—for example, remains highly dependent on New York City for jobs. According to the Bureau of Labor Statistics, the New York-Northern New Jersey-Long Island unemployment rate was 8.2 percent as of December 2010.

“[New Jersey’s] done a little better over the last year than it did previously; private employers are hiring more than they have in the past, but the government is hiring less,” adds Ron Ladell, vice president of development for N.J. at AvalonBay Communities Inc., which owns and operates 4,800 apartment homes throughout the state.

“I think that’s reflective of the new governor [and] the fact that budgets are under severe stress,” he says. “New Jersey is recognizing for the first time in a long time that it needs to be business-friendly, and part of that is to keep check on increase in property taxes and income taxes.”

Up-and-coming in New York

The inventory of market-rate apartments in New York City is projected to expand 0.9 percent in 2011 with the completion of 1,450 units, according to Marcus & Millichap’s report. Last year, 7,600 units were completed—the record-high of the decade.

“During the ‘90s and ‘00s, there was a big housing boom that took place in New York City, but from the ‘50s through the ‘90s there was almost no housing built, in relative terms,” says Scott Walsh, director of market research at TF Cornerstone. “If you study just the amount of housing we need to replenish outdated or very old housing stock … we continue to need to build just to keep pace with replacing housing stock and employment growth.”

“With that sort of tightening, you really see a … lack of need to give concessions,” says Fred Harris, senior vice president of development in New York for AvalonBay, who adds that while some of the new product continues to offer concessions, they are “less generous.”

In 2011, asking and effective rents at large, market-rate communities are expected to increase 6.2 percent and 6.9 percent, respectively, according to Marcus & Millichap.

Meanwhile, Manhattan’s outer boroughs have seen the development of many up-and-coming, highly desirable neighborhoods.

“Downtown Brooklyn [went from] zero to 60. Over a 20-month period there were several thousand new apartments,” recalls Harris of AvalonBay, which recently finished lease-up of its 631-unit community in Brooklyn’s Fort Greene.

“Downtown Brooklyn has tremendous upside opportunity over the next 10 to 15 years,” says Parker, adding that the multiple subway lines that provide access to Manhattan, as well as the new face of local retail, will help to keep the neighborhood highly desirable.

At the same time, despite the heavy concentration of new supply in Long Island City, rents haven’t softened, Harris reports.

“Long Island City had a tremendous wave of new development,” says Parker, who believes the neighborhood, which is just minutes from Midtown’s office corridor, will continue to gentrify as retail options improve. He predicts it will experience significant rent growth in the next seven to 10 years.

The Queens West Development Corp., a state development authority, has been working to redevelop Long Island City’s formerly industrial waterfront, where TF Cornerstone is currently developing six of the seven parcels comprising East Coast. (At build-out, the six buildings, which include one condominium, will add 2,602 units to the neighborhood.) Mayor Bloomberg’s administration also recently selected Related Cos., Phipps Houses and Monadnock Construction to develop phase one of the 30-acre Hunters Point South, which, when complete, will include up to 5,000 units—60 of which will be affordable to middle-income families.

“There has been a resurgence in New York of accessing the waterfront,” says Walsh. “It will take 10 years, but ultimately East Coast … will be part of a network of parks that will go down through Brooklyn … which is great for everyone in the boroughs.

“There are some proposals of pedestrian bridges over the creek that separates Greenpoint from Long Island City. People haven’t thought of these neighborhoods as being linked because the waterfront access, which is the connection, hasn’t existed,” Walsh points out.

While a significant portion of AvalonBay’s New York City inventory is located in Brooklyn and Queens, it continues to be driven by the Manhattan employment base, says Harris, who is encouraged by Google’s recent purchase of a nearly $2 million office building in Manhattan.

But the connection between the boroughs continues to pose some challenges. “Brooklyn is a bedroom community to Manhattan, and the subway systems are designed to move people to Manhattan, not around Brooklyn,” points out Parker, “so one of the risks facing Brooklyn, in terms of its multifamily housing and its rent growth and values to the property, is overall employment of people that live there.”

The financial district is a huge employer for a lot of Brooklyn residents, adds Parker, and since “the job growth we’ve seen has not necessarily come from the financial industry … it could hurt more affluent areas of Brooklyn significantly if it doesn’t continue to improve.”

In the meantime, investment activity is projected to continue its acceleration through the first half of 2011, according to Marcus & Millichap.

Cap rates are “very specific to what your average rents are, and the unit mix of the building, and whether it’s a free-market building or if it’s a rent-stabilized or rent-controlled building,” notes Parker. However, he adds, typically the more affluent neighborhoods, such as Park Slope or Brooklyn Heights for example, will see market-rate apartments trade in the 5.5 percent to 6.5 percent cap range.

“Numbers can go significantly lower on rent-stabilized and rent-controlled apartments where rents are artificially lower than the market actually demands,” he says. “We see trades anywhere from a 3.5 cap to a 6.5 cap.”

Average cap rates in Manhattan rose to the high-5 percent range last year, according to Marcus & Millichap; this reflects sales of smaller properties, though some compression is likely in 2011 as institutions and REITs pursue larger assets.

Parker has observed interest from three distinct buyer pools: institutions; the foreign community, many of whom will partner with a local operator; and the local buyer pool. The boroughs are mostly dominated by these local players.

With so many bright spots, however, come some potential risks, including the city’s high property taxes that, Parker notes, “are really hurting owners right now.” And, he adds, because New York City landlords are required to provide heat and hot water to their residents, an increase in the price of oil can have a tremendous negative impact on owner expenses.

N.J.’s high barrier-to-entry

The New Jersey suburbs, particularly those in the north, tend to be Manhattan-centric as well, though “there are a lot of office campuses and a lot of back office [employment],” according to Steve Scioscia, senior vice president of acquisitions for the Northeast region of Phoenix Realty Group (PRG), which is actively investing in existing value-add opportunities and pursuing joint-venture development of new multifamily projects in the Tri-State area.

Meanwhile, government and education are the primary economic drivers of the Central Jersey markets, while Philadelphia tends to drive the economy further south.

According to Marcus & Millichap, significant vacancy improvements are expected for the northern and southern sections of New Jersey. In northern New Jersey, hiring is expected to pick up in Essex, Hudson and Bergen Counties, and a lack of new supply will contribute to a vacancy level that hasn’t been seen since the start of the recession.

In the south, Philadelphia’s tightening occupancies will contribute to an improvement in the suburbs, and Central New Jersey is expected to see a decline in vacancy of 60 bps, to 3.4 percent—the lowest of the state.

According to Marcus & Millichap, only about 1,100 units are slated for delivery this year, down from nearly 2,400 units in 2010.

“As soon as you’re outside of the [city] it’s very difficult to get projects approved,” Scioscia points out. “In New Jersey, most towns are pegged to a density requirement. To get the same project to work economically as rentals … you have to go back in and get it reapproved for greater density.”

AvalonBay is, however, building new. “With limited supply, we found a lot of opportunities,” says Ladell. The company is nearing completion on 180 units in West Long Branch. The community is 70 percent leased, which Ladell reports, is “on target with regard to budget and deliveries.” Also started are two other communities, including the 406-unit Westmont Station I in Wood-Ridge, which will offer 27,000 sq. ft. of retail. A second phase on the 70-acre site will be developed as for-sale units by another developer. Avalon North Bergen will offer 164 apartments and 17,000 sq. ft. of retail just one mile from the Lincoln Tunnel.

Asking and effective rents in New Jersey are expected to increase 2.7 percent and 3.8 percent, respectively, according to Marcus & Millichap. Scioscia observes that some higher-tier properties are growing at a slower rate, however.

Ladell does point out that the dollar number does tend to be higher in Northern New Jersey. Rent growth is slightly higher in this region as well, which Ladell attributes to land being slightly more expensive in Northern New Jersey.

Scioscia reports that Northern N.J. tends to be “the risk premium” in the state, with assets trading about half a point higher than those in Manhattan.

Marcus & Millichap reports that average state-wide cap rates will remain in the low-7 percent range through the first half of 2011. Average cap rates in Central and Southern New Jersey will range from about 7.3 percent to 7.8 percent this year, according to the report.

Scioscia sees the greatest opportunity in value-add properties, such as the company’s recent $24.2 million acquisition of a 548-unit community in East Orange, N.J.

Meanwhile, Ladell believes the area’s greatest bright spots are its strong demographics. In New Jersey, he notes, “there’s a component of immigration that drives some of the population increase.”

And, he adds, “it’s nice to see state government … focusing on becoming more business-friendly. We’ll still always remain a high barrier-to-entry market, and we’re still governed by Home Rule, but if the state agencies can continue to understand some of the challenges that we face, I think that will be a very positive result.”